There are basically two ways of figuring your tax bracket: the average method and the marginal method. Both are important to know for planning purposes. Let’s assume the following:
Taxpayer Iwanabe Astar is single living in NYC. For year 2001, here’s what his/her tax return showed:
Income $87,000
Deductible Expenses $37,000
Taxable Income $50,000
Tax-Fed, NY, NYC $14,913
For Iwanabe, his/her average tax bracket is 17.14 percent. This is computed by simply dividing 14,913 by 87,000. Iwanabe then knows that on average, for every dollar earned in this bracket throughout the year, the tax is going to be about 17 percent.
However, since the tax rates are set up to gradually increase as your income increases, the marginal rate is totally different. For example, on the $50,000 taxable income above, the IRS taxes the first $27,050 at 15 percent. The remaining $22,950 is taxed at 27.5 percent. NY State and NYC have similar schedules.
Let’s say that on Dec 31st, Iwanabe gets a New Year’s Eve gig and earns another $1,000, which puts the income at $88,000. What does this extra $1,000 cost in taxes?
Looking at the average, it would cost about $171 (17.14 percent). But marginally, because of the gradual increase in rates, assuming Iwanabe already earned $87,000 by Dec 30th, the tax on the extra $1,000 would be $380 (38 percent), federal, state and city. (Trust me on the computation).
The reason this is important information is that not only does it affect income, but it also affects deductions. If Iwanabe were thinking of spending money on an item that would be a tax deduction, knowing the marginal bracket means knowing how much tax is saved by purchasing the item. In the example above, if Iwanabe bought a deductible item (or took extra coaching or lessons) at the end of December for $1,000.00, it really would only cost $620.00 since he/she would be able to avoid reaching the marginal bracket of 38 percent. Coaches and teachers wanting extra holiday income should copy this article and give it to all students toward the end of the year.
Gordon Voorhees is an Enrolled Agent (EA) whose financial planning and tax practice has been located in NYC for over 30 years. His client base is primarily in the performing arts. Enrolled Agents are Federally Authorized Tax Practitioners who have technical expertise in the field of taxation and are empowered by the United States Treasury Department to represent taxpayers before all administrative levels of the IRS. For more information about EAs, please visit You can contact Mr. Voorhees at gvoorhees@classicalsinger.com.
